The Financial Accounting Standards Board (FASB) is seeking constituent comment and perspectives on the potential bifurcation of insurance and reinsurance contracts into insurance components and financing components as part of a broader initiative to improve the financial reporting for insurance accounting.
This Invitation to Comment (ITC) reflects the FASB’s concern about a possible lack of transparency in the financial statements of both policyholders and(re)insurance companies relating to the depiction of insurance risk associated with contracts that include terms or features that significantly limit the actual amount of risk transferred. Such contracts are frequently referred to as finite risk contracts, though the ITC is not exclusive to finite risk contracts.
Current accounting standards providing guidance for insurance accounting mainly address financial reporting by insurance and reinsurance companies. These standards provide only limited guidance on how to account for insurance contracts by policyholders. Moreover, insurance and reinsurance contracts often have both insurance and financing components which are combined and accounted for simply as “insurance contracts”.
The Board seeks to gather information regarding whether bifurcation would improve financial reporting by providing users of financial statements with better information about the economic substance of insurance arrangements. Bifurcation would divide some or all such contracts into two main components for financial reporting purposes. Components of such contracts that transfer significant insurance risk would be accounted for under existing insurance accounting guidance and generally provide an income statement benefit (recovery) in the period of an insured loss. Financing components that are accounted for as deposits would be recorded as an asset by the policyholder. Any recovery from an insured event would reduce the deposit and not have a significant income statement benefit.
“The FASB is encouraging the active participation of all constituents in this process, however, we are particularly interested in hearing from noninsurance company policyholders – including smaller and private companies,” Jeffery Cropsey, FASB Project Manager, said in a prepared statement. “Bifurcation could have a significant impact on the way some insurance contracts are accounted for and we want to ensure that all parties have an opportunity to carefully consider the issues and express their points of view.”
The ITC requests specific information from buyers and sellers of insurance and reinsurance contracts and the users of their financial statements. The comment deadline is August 24, 2006.